Auditing and Assurance: Concepts and Applications 1

BM2008/BM2015 – Auditing and Assurance: Concepts and Application 1 & 2
Table of Contents
Auditing and Assurance: Concepts and Applications 1
(Weeks 6-7) Audit of Cash ............................................................................................................................ 2

Introduction to Audit of Cash ..................................................................................................................... 2
Audit Objectives and Procedures .............................................................................................................. 3
(Weeks 7-8) Audit of Receivables ................................................................................................................. 4
Introduction to Receivables ....................................................................................................................... 4
(Week 11) Audit of Inventories ...................................................................................................................... 6
Introduction to Inventories ......................................................................................................................... 6
(Week 12) Audit of Investments .................................................................................................................... 8
Introduction to Investments ....................................................................................................................... 8
(Weeks 15-16) Audit of Property, Plant, and Equipment ............................................................................ 10
Introduction to Property, Plant, and Equipment ...................................................................................... 10
Audit Objectives and Procedures ............................................................................................................ 12
(Weeks 1-2) Audit of Intangible Assets and Prepayments ......................................................................... 13

Audit of Intangible Assets ........................................................................................................................ 13
(Weeks 2-3) Audit of Current Liabilities ...................................................................................................... 14
Introduction to Current Liabilities ............................................................................................................. 14
(Week 6) Audit of Noncurrent Liabilities ...................................................................................................... 16
Introduction to Noncurrent Liabilities ....................................................................................................... 16
(Weeks 7-8) Audit of Shareholders’ Equity ................................................................................................. 17
Introduction to Shareholders’ Equity ....................................................................................................... 17
(Week 12) Correction of Errors ................................................................................................................... 21
Accounting Errors .................................................................................................................................... 21
Error Correction ....................................................................................................................................... 21
Third Year Comprehensive Examination (TYCE) Handout *Property of STI

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(Weeks 6-7) Audit of Cash
Introduction to Audit of Cash
Cash is a legal tender that can be used to exchange goods, debt, or services. It is one of the most important
assets of a business. Almost all the entity's transactions ultimately result in either receipt or payment of
cash. Cash usually includes cash in bank, cash on hand, and cash equivalents. Cash equivalents (CE) are
short-term, highly liquid instruments that are both easily convertible to a known amount of cash. Examples
of cash and cash equivalents include, but not limited to, petty cash fund, payroll fund, money orders,
cashier's checks, treasury bills, and others.
Components of Cash and Cash Equivalents Account
Included as Cash Excluded as Cash

Cash on Hand
1. Currencies and coins ✓
2. Money order ✓
3. Bank drafts ✓
4. Checks
a. Cashier's check ✓
b. Certified check ✓
c. Customer's check ✓
d. Manager's check ✓
e. Personal check ✓
f. Traveler's check ✓
g. Customer's postdated check ✓
h. Customer's NSF/DAIF check ✓
i. Customer's stale check ✓
j. Company's unreleased check ✓
k. Company's postdated check ✓
l. Company's stale check ✓
Cash in Bank
1. Checking Account ✓
2. Savings Account ✓
3. Time Deposit ✓ (part of CE)
4. Compensating balance
a. Legally restricted ✓
b. Not legally restricted ✓
5. Deposit in Foreign Bank
a. Legally restricted ✓
b. Not legally restricted ✓
c. Silent ✓
6. Deposit in Closed bank ✓
7. Bank Overdraft
a. Different Bank ✓
b. Same Bank ✓
c. Silent ✓
Cash Fund
1. Cash fund for operation
a. Petty cash fund ✓
b. Revolving fund ✓

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Included as Cash Excluded as Cash

c. Change fund ✓
d. Payroll fund ✓
e. Tax fund ✓
f. Interest fund ✓
g. Dividend fund ✓
h. Travel fund ✓
2. Cash fund not for the operation
✓ (if disbursement is w/in ✓ (if disbursement is
a. Sinking fund
12 months) beyond 12 months)
✓ (if disbursement is w/in ✓ (if disbursement is
b. Pension fund
12 months) beyond 12 months)
c. Preference share redemption ✓ (if disbursement is w/in ✓ (if disbursement is
fund 12 months) beyond 12 months)
d. Plant acquisition fund ✓
e. Depreciation fund ✓
f. Contingency fund ✓
g. Insurance fund ✓
Included as CE Excluded as CE
Cash Equivalents (CE)
1. Time deposit ✓ (within 3 months) ✓ (beyond 3 months)
2. Money order ✓ (within 3 months) ✓ (beyond 3 months)
3. Treasury shares ✓ (within 3 months) ✓ (beyond 3 months)
4. Investment in preference share with
✓ (within 3 months) ✓ (beyond 3 months)
redemption date
Audit Objectives and Procedures

An audit program of representative year-end substantive testing procedures in the examination of cash:
Assertions Audit Objectives Audit Procedures

Existence or A. All cash on the statement of 1. Analysis of cash balance and
Occurrence financial position at a given date is reconcile to the general ledger.
held by the entity or by others (e.g., 2. Bank confirmation.
a bank) for the entity. 3. Cash count procedures for cash
on hand.
4. Test on bank reconciliation.
5. Tracing bank transfers.
Completeness B. All cash owned by the entity at the 6. Cut-off bank statement.
reporting date is included in the 7. Prepare proof of cash.
statement of financial position. 8. Cash cut-off tests.
Rights and C. The entity owns, or has a legal right 9. Review bank statements and
Obligations to, and has unrestricted use on all replies to bank confirmation
the cash on the statement of letters.
financial position at the reporting
date.
Valuation or D. Cash, including bank balances, is 10. Existence of cash in banks under
Allocation stated at realizable value and receivership, cash subject to a
agrees with supporting schedules. court restraining order, in foreign
currency.
Presentation and E. Cash, including bank balances, is 11. Checks with large or unusual
Disclosure properly classified, described, and payments to related parties.
disclosed in the financial

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statements, including notes, 12. Proper financial statement
following the PFRS. presentation and disclosure of
F. Lines of credit, loan guarantees, cash.
compensating balance agreements,
and other restrictions (liens) on
cash balances are appropriately
identified and disclosed.
(Weeks 7-8) Audit of Receivables
Introduction to Receivables
Receivables are debts owed to a company by its customers for goods or services delivered or used but
not yet paid for.
The audit of receivables and revenue (e.g., sales) represents significant audit risk because:
1. Many incidences of financial statement fraud have involved the overstatement of receivables and
revenue;
2. Revenue recognition may be based on complex accounting rules; and
3. Receivables and revenue are usually subject to valuation using significant accounting estimates.

When auditing accounts receivable and sales, the principal objective for the substantive tests is to
determine the following:
Assertion Category Audit Objectives
Existence or Occurrence All receivables on the statement of financial position are authentic claims of
the entity, and all sales have really occurred and pertained to the entity.
Completeness All authentic claims of the entity for amounts receivable are included in the
statement of financial position, and all sales have been included in the
statement of comprehensive income.
Cut-off Sales have been recorded in the proper accounting period.
Valuation and Allocation Receivables are carried at their net realizable (collectible) value (i.e., the
gross receivables are properly stated with appropriate allowances provided
for doubtful accounts, discounts, returns, warranties, and similar items).
Accuracy Sales have been accurately recorded in the statement of comprehensive
income.
Rights and Obligations The entity owns or has a legal right to all the receivables on the statement of
financial position at the reporting date.
Presentation and Receivables and sales are properly classified, described, and disclosed in
Disclosure & the financial statements, including notes, in accordance with PFRS.
Classification Pledged, discounted, or assigned accounts receivable are properly
disclosed. Related party receivables and sales are properly disclosed.
Audit Procedures for Receivables and Sales

The auditor's primary substantive procedures for receivable balance and sales transactions will typically
include the following:
1. Reconciliation of subsidiary ledger with the general ledger;
2. Confirming receivables and reviewing subsequent cash receipts;
3. Analyzing notes receivable and related interest;
4. Evaluating the adequacy of the allowance for doubtful accounts, including the appropriateness of
the methodology used to calculate the allowance;
5. Performing accounts receivable and sales cut-off;
6. Checking the appropriate valuation of accounts receivables denominated in foreign currencies;
7. Investigating any transactions with or related party receivables;

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8. Analyzing credit balances and unusual items;

9. Ascertaining whether any receivables have been pledged or assigned; and
10. Performing analytical procedures
Trade Receivable and Allowances

Trade receivables are the total amounts owing to a company for goods or services it has sold, which are
reflected in invoices that the company has issued to its clients but has not yet received payments for. For
an invoice amount to be added to trade receivables, full payment must be expected within one (1) year.
Expected question(s):
1. What is the balance of accounts receivable at year-end?
2. What is the balance of allowance for doubtful accounts at year-end?
3. What is the amount of bad debt expense for the year?
4. What is the net realizable value of accounts receivable at year-end?
Notes Receivable
Notes receivable is a balance sheet item that records the value of promissory notes that a business is owed
and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive
the amount outlined in the legal agreement. Promissory notes are a written promise to pay cash to another
party on or before a specified future date.
If the notes receivable is due within a year, it is treated as a current asset on the balance sheet. If it is not
due until a date that is more than one year in the future, then it is treated as a non-current asset on the
balance sheet.
1. What is the initial measurement of notes receivable (fair value at the date received)?
2. What is the gain or loss on the sale of property, plant, and equipment?
3. What is the amount of revenue or sales where the consideration received is in the form of notes?
4. What is the subsequent measurement of notes receivable (carrying amount at year-end)?
5. What is the interest income for the year?
6. What is the interest receivable as of year-end?
7. What is the current portion of the notes receivable?
8. What is the non-current portion of the notes receivable?
Loans Receivable (LR)

1. What is the initial measurement of loans receivable (fair value at the date received)?
2. What is the subsequent measurement of loans receivable (carrying amount as of year-end)?
3. What is the interest income for the year before impairment?
4. What is the impairment loss for the year?
5. What is the carrying amount of the loans receivable subsequent to the date of impairment?
6. What is the interest income for the year after impairment?
Receivable Financing
• Assignment of Accounts Receivable. It is an agreement between a lending company and a
borrowing company in which the latter assigns its accounts receivable to the former in return for a loan.
• Factoring. Factoring is a financial transaction in which a company sells its accounts receivable to a
financing company specializing in buying receivables (called a factor) at a discount.
• Discounting of Notes Receivable. A holder of a note can readily convert it to cash by discounting it
at a bank, either with or without recourse. The bank accepts the note and gives the holder cash equal
to its maturity value less a discount computed by a discount rate to the maturity value. The bank gets

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its money back plus the discount when its maker pays the note at maturity. If the note is not paid at
maturity, the bank can collect it from the original holder if it was discounted with recourse. If the
arrangement is without recourse, the bank must find another remedy.
a. Discounting without recourse – The holder/endorser is not held liable in case the maker fails to
pay.
b. Discounting with recourse – The holder/endorser is held liable in case the maker fails to pay.
The discounting is accounted for either (a) conditional sale, or (b) secured borrowing.
Assignment
1. What is the balance of accounts receivable - assigned?
2. What is the balance of loans payable?
3. What is the equity to be disclosed in the notes to the financial statement?
Factoring
1. What is the net proceeds from factoring of receivable?
2. What is the cost of factoring?
Discounting
1. What is the net proceeds from discounting of notes receivable?
2. What is the gain or loss from discounting of notes receivable?
3. What is the journal entry for discounting of notes receivable?
(Week 11) Audit of Inventories
Introduction to Inventories
Inventories are assets held for sale in the ordinary course of business, in the process of production for such
sale, or in the form of materials or supplies to be consumed in the production process or the rendering of
services.
Inventories
Raw Work in Finished Factory

Materials Process Goods Supplies
Inventories under consignment
Consignor INCLUDE (goods sent out, shipped out, out on)
Consignee EXCLUDE (goods held on, received on)
Goods in transit
Shipping Terms Owner
a. FOB Shipping Point

b. FOB Seller
c. FOB CIF (Cost, Insurance & Freight) Buyer
d. FOB FAS (Free alongside)
a. FOB Destination Seller

b. FOB Buyer

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c. FOB Ex-ship
Goods under special term of sale
1. Bill and hold arrangement

2. Sale on installment Buyer
3. Special order
1. Lay-away sale
2. Sale on approval Seller
3. Sale with a buyback agreement
Inventoriable expenditures
Expenditure Treatment
1. Freight
a. Freight-in Inventoriable
b. Freight-out Not inventoriable
2. Insurance
a. During delivery Inventoriable
b. After delivery Not inventoriable
3. Storage cost
a. Storage of Work-in-process Inventoriable
b. Storage of Raw Materials and Finished goods Not inventoriable
4. Waste, spoilage of resources
a. Normal Inventoriable
b. Abnormal Not inventoriable
5. Interest incurred
a. Non-routinely manufactured Inventoriable
b. Routinely manufactured/ Silent Not inventoriable
6. Tax
a. Non-recoverable Inventoriable
b. Recoverable Not inventoriable

Audit Objectives
When auditing inventories and cost of sales, the principal objective for the substantive tests is to determine
the following:

Existence or A. All inventories included on the 1. Observing during inventory
Occurrence statement of financial position are count and performing test
held by the entity or by others for the counts.
entity and purchases (cost of sales) 2. Confirmation of inventories held
have really occurred and pertain to by others.
the entity.

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Completeness B. All inventories owned by the entity at 3. Reconciliation of Inventory
the reporting date are included on the Summary Sheet with General
statement of financial position, and all Ledger.
cost of sales is included in the
statement of comprehensive income.
Cut-off C. Purchases (cost of sales) have been 4. Performing year-end purchases
recorded in the proper accounting and inventory cut-off.
period.
Valuation and D. Inventories are carried at the lower 5. Checking appropriate valuation
Allocation cost and net realizable value (NRV). in accordance with accounting
policies.
6. Performing lower of cost or net
realizable value test.
Rights and E. The entity owns, or has a legal right 7. Determining whether any
Obligations to, all the inventories reported on the inventories have been pledged
statement of financial position. and reviewing purchase
commitment.
Presentation and F. Inventories are properly classified, 8. Proper and adequate financial
Disclosure and described, and disclosed in the statement presentation and
Classification financial statements, including notes, disclosure
in accordance with the applicable
PFRSs. Pledged inventories are
properly disclosed.
(Week 12) Audit of Investments
Introduction to Investments
Investments are financial assets representing a company's right to receive cash from its stake in bonds,
shares, real estate, etc. The intent behind making such investments is to generate investment income
(interest and dividend) and benefit from expected capital gain.
Major categories of investments include:

a. Debt securities are financial instruments representing a right to a determined stream of cash flows
for a definite period, such as bonds.
b. Equity securities are financial instruments representing residual (ownership) interest in a
company, such as shares of common stock, etc.
c. Derivative securities are financial instruments which 'derive' their value from other financial
instruments, such as forward contracts, futures contacts, options, etc.
From the auditors' point of view, the most important group of investments consists of stocks and bonds
because they are found more frequently and usually are of greater value than other kinds of investment
holdings. Commercial papers issued by corporations, mortgages and trust deeds, and the cash surrender
value of life insurance policies are other types of investments often encountered.
Accounting classification of debt securities

Under the US generally accepted accounting principles (GAAP), the classification is dictated by the
instruments' legal form. The US GAAP retains the legacy classification categories for many debt securities.
Under International Financial Reporting Standards (IFRS), classification depends on (a) the business model
and (b) cash flow characteristics of the instrument. An investor first determines whether its business model
holds the asset to collect cash flows or sell it to realize a capital gain. Second, it assesses whether the
asset's cash flows are solely payments of principal and interest (called the SPPI test). Categories of debt
securities under IFRS include:

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a. Amortized cost. Debt securities are classified at amortized cost if the company's business model
is to hold the asset to collect cash flows. Those cash flows are solely payments of principal and
interest.
b. Fair value through other comprehensive income (FVOCI). Debt securities are classified at
FVOCI if the investor's business model collects cash flows and sells the asset. The cash flows are
solely payments of principal and interest.
c. Fair value through profit or loss (FVPL). These are debt securities that do not qualify for
classification at either amortized cost or FVOCI are classified at FVPL.
Accounting for equity securities

Accounting for equity investments depends on the extent of ownership. It is classified based on the holding
entity's intention and the level of the investor's influence over the investee's operating and financial policies.
a. Investment in a subsidiary. It is based on controlling interest, and the financial statements may
be consolidated. Control may be obtained in various circumstances and not solely due to direct the
financial and operating policies. An investor controls an investee when it is exposed, or has rights,
to variable returns from its involvement with the investee and can affect those returns through its
power over the investee. Where Company A owns more than 50% equity of Company B, it has
control over Company B and is required to prepare consolidated financial statements.
b. Investment in associates. The investor classifies the equity investments as investments in
associate when there is a significant influence in the investee company's operating and financial
policies. Company A owns anywhere between 20% and 50% of Company B's equity. It has
significant influence over Company B. It is required to account for investments in Company B using
the equity method.
c. Fair value through profit or loss (FVPL) – This is the classification when the equity securities are
held for trading. There is neither control nor significant influence in the operating and financial
policies of the investee company.
d. Fair through other comprehensive income (FVOCI) – When there is neither control nor
significant influence and the equity securities are non-trading, the investor makes n irrevocable
choice designating at the date of initial recognition of the securities either as FVPL or FVOCI.
For example, If Company A owns less than 20% of Company B's equity, neither consolidation nor
equity method is required.

Audit Objectives
When auditing investments, the principal objective for the substantive tests is to determine the following:
Assertion Audit Objectives Audit Procedures

Existence All recorded investments on the 1. Obtain or prepare a listing of securities
statement of financial position exist. and investments owned by the company
and related revenue accounts and
reconcile them to the general ledger.
Occurrence All recorded income from 2. Inspect securities on hand.
investments has accrued to the 3. Obtain confirmation of the securities held
entity at the reporting date. by others.
Completeness All investments owned by the entity 4. In addition to audit procedures 2 and 3,
at the reporting date are included in vouch for the selected purchases and
the statement of financial position. sales transactions of securities during the
All income accruing from year.
investments at the reporting date has
been recorded.

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Assertion Audit Objectives Audit Procedures

Rights and The entity owns or has a legal right 5. In addition to audit procedures 2 and 3,
Obligations to the investments included in the verify the clients' cut-off of securities
statement of financial position. transactions.
6. Perform analytical procedures.
7. Compute revenue from securities
independently.
Valuation and Investments are included in the 8. Determine the market value of securities
Allocation statement of financial position at the at the statement of financial position date.
appropriate amounts. 9. Evaluate the method for accounting for
securities.
10. Test impairments of investments.
Accuracy Investment income is included in the 11. Detailed minutes of meeting review.
statement of comprehensive income 12. Evaluate financial statement presentation
at the appropriate amount. and related revenue or loss accounts.
(Weeks 15-16) Audit of Property, Plant, and Equipment
Introduction to Property, Plant, and Equipment
The term Property, plant, and equipment (PPE) refer to tangible items that:
a) are held for use in the production or supply of goods or services, for rental to others, or
administrative purposes; and
b) are expected to be used during more than one period.
PPE normally constitutes a significant portion of the total assets, particularly in a manufacturing entity. Audit
of PPE, therefore, assumes considerable importance. When planning for the audit of PPE, the auditor
considers that the amounts for this PPE is material to the statement of financial position and expect that
the account balances do not necessarily change significantly from year to year.
The auditor normally assesses control risk at a maximum level and performs extensive substantive tests
that emphasize the review of significant additions, disposals, and analytical procedures to test the
provisions for depreciation and depletion. In addition, auditors should also obtain evidence about related
accounts of depreciation expense, accumulated depreciation, lease (rent) expense, impairment loss (if
any), and repairs and maintenance expense.
Components of Property, Plant, and Equipment

The following are the components of PPE, among others:
Land Store and Office Equipment

Land Improvement Furniture and Fixtures
Building Leasehold Improvement
Machinery Bearer Biological Assets
Delivery Equipment
Bearer biological assets (BBA) are matured biological assets held for more than one financial period
capable of bearing consumable biological assets (CBA) to be harvested as agricultural produce. BBA are
held for generating income from the sale of produce; for example,
1. Livestock from which milk is produced
2. Grapevines
3. Oil palm and rubber trees
4. Fruit trees, and
5. Trees from which firewood is harvested while the tree remains.

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Bearer biological assets are not agricultural produce but, rather, are self-regenerating. Bearer plant assets
are accounted as PPE under PAS 16, provided it will meet the criteria in the said standard, while bearer
animals are accounted as biological assets under PAS 41. Produce growing on bearer plants is a biological
asset.
Measurement of Property, Plant, and Equipment

• Initial recognition – At cost
• Subsequent measurement – either (for an entire class):
o Cost
o Revaluation Model
Summary of the measurement of PPE:
Purchase Price
Cash basis 1. Cash
2. Lump-sum/basket price - allocate on the basis of relative fair value
On account 1. Invoice price minus cash discount, whether taken or not
Installment Method 1. Cash price equivalent
2. Present value if no cash price equivalent
Issuance of share capital 1. FV of property received
2. FV of share capital
3. Par value or stated value of share capital
Issuance of bonds 1. FV of bonds payable
payable 2. FV of property received
3. Face value of bonds payable
• With commercial substance

- No cash involved
1. FV of property given up
2. FV of property received
3. CA of property given up
- With cash involved
FV of property given up + cash paid (payor)
Exchange FV of property given up + cash received (recipient)
• No commercial substance - no gain/loss on exchange
- CA of property given up
- Cash paid is still added; cash received is still deducted
• Trade in
- FV of property given up +cash paid
- Trade in value of the property given up + cash paid
(in effect FV of property received)
• From shareholders = Donated capital
Donation - FV • From non-shareholders = Income if unconditional;
initially Unearned income if conditional
Self-Construction Direct Materials + Direct Labor + Factory Overhead
Depreciation Methods
1. Straight line
• Depreciable amount / useful life
• Depreciable amount x depreciable rate

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Depreciable rate = 1 / useful life
2. Group / Composite
• Cost x depreciation rate
Depreciation rate = Annual depreciation / total cost
3. Units of production
• Output x Depreciation rate
Depreciation rate = Depreciable amount / Total estimated output
4. Working hours
• Hours used x depreciation rate
5. Sum of the years' digits

• [(life + 1) /2] x life
6. Declining
• Previous carrying amount x depreciation rate
Regular = 1 – (nth root of (Residual value /cost)]
150% = (1 / useful life) x 1.5
200% = (1 / useful life) x 2
7. Retirement
• Cost of asset retired – Proceeds from retirement
8. Replacement
• Replacement cost of asset retired – Proceeds from retirement
9. Inventory
• Recorded balance of asset – Value at period end

The financial statements assertions, specific audit objectives, and the commonly applied audit procedures
used for the property and equipment are summarized below:

Existence or Occurrence A. To determine whether 1. Obtain or prepare a
property and equipment summary of property and
included in the statement of equipment transactions and
financial position physically analysis of the accumulated
exist. Additions include only depreciation during the year
the capitalizable cost of and reconcile to the ledger.
assets purchased, 2. Conduct physical inspection
constructed, or leased and of a major acquisition of plant
retirements are removed. and equipment.
Completeness B. To determine that property 3. Vouch additions to property
and equipment includes all and equipment during the
capitalizable costs and year.
capitalizable costs are not 4. Investigate disposals and
expensed. retirements of property and
equipment during the year.
Rights and Obligations C. To determine that the 5. Examine evidence of legal

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company has legal title or ownership of property and
Equivalent ownership rights equipment.
to property and equipment 6. Examine lease agreement
included in the statement of on property and equipment
financial position and the leased to and from others.
statement of financial 7. Review rental revenue from
position and the related land, buildings and
lease obligation of equipment owned by the
capitalized leased assets is client but leased to others.
recognized.
Valuation or Allocation D. To determine that property 8. Analyze repair and
and equipment is stated at maintenance expense
cost and allowances for accounts.
depreciation or depletion are 9. Investigate the status of the
computed based on property and equipment not
acceptable and consistent in current use.
methods. 10. Test client's computation of
depreciation.
11. Perform analytical
procedures for property and
equipment.
Presentation and E. To determine that property 12. Review financial statement
Disclosure and equipment are properly presentation and disclosure
described and classified in for property and equipment
the statement of financial and for related revenue and
position and related expense.
disclosures are adequate.

(Weeks 1-2) Audit of Intangible Assets and Prepayments
Audit of Intangible Assets

Intangible assets are non-monetary assets without physical substance. An intangible asset is identifiable
when it:
• Is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged,
either individually or together with a related contract) or
• Arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or other rights and obligations.
Intangible assets include patented technology, computer software, trademarks, copyrights, formulas,
franchise agreements, and goodwill acquired in a business combination. Since intangible assets lack
physical substance, their value lies in the rights and economic advantages afforded in their ownership.
Because of their intangibility, they are more difficult to identify than other assets like property, plant, and
equipment.
An intangible asset can be classified as either:

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• Indefinite life: No foreseeable limit to the period over which the asset is expected to generate net
cash inflows for the entity. A company's brand name is considered an indefinite intangible asset
because it stays with the company for as long as it continues operations.
• Finite life: A limited period of benefit to the entity. An example of a definite intangible asset would
be a legal agreement to operate under another company's patent, with no plans of extending the
agreement. The agreement thus has a limited life and is classified as a definite asset.

The financial statement assertions, specific audit objectives, and the common audit procedures traditionally
used to achieve the objectives for intangibles are as follows:

Existence or occurrence To determine that intangible 1. Obtain an analysis of ledger
assets exist and are accounts for intangibles.
represented by contractual 2. Discuss the policy and
rights, privileges, or earning examine documentation
power owned by the company. supporting intangible assets.
3. Test the probability of future
economic benefits that will
flow to the entity.
Completeness To determine that all 4. Vouch additions to or
transactions related to acquisitions during the year.
intangibles have been properly 5. Evaluate dispositions and
recorded write-offs during the year
Rights and Obligations To determine that the company 6. In addition to audit
owns the intangible assets procedure no. 2, perform
analytical procedures
Valuation or Allocation To determine that intangible 7. In addition to audit
assets are stated at cost less procedures no. 3 and 4,
amortization evaluate amortization policy
and verify computation and
amortization
Presentation and Disclosure To determine whether 8. Evaluate financial statement
presentation and disclosures presentation and disclosure
concerning intangibles are for intangible assets.
adequate and per PAS/PFRS.
(Weeks 2-3) Audit of Current Liabilities
Introduction to Current Liabilities

The IAS 37/PAS 37 Provisions, Contingent Liabilities, and Contingent Assets define liability as "a present
obligation of the entity arising from past events, the settlement of which is expected to result in an outflow
from the entity of resources embodying economic benefits."
Based on the definition, a liability possesses the following essential characteristics:

1. Present obligation - This states that liability arises from a responsibility assumed by the entity. Present
obligation can be either be legal or constructive. Legal obligation arises from contracts or any statutory
requirements. In contrast, constructive obligation arises from established business practices that aim
to maintain a good relationship with customers, as well as the community.
2. Past event - This states that liability originates from a past event or transaction. This past event is
commonly known as an obligating event. This event puts an entity into a position to settle the present
obligation, with no alternative courses of action.

Page 14 of 22
3. Outflow of future economic benefits - This states that all accounting liability requires the payment of
money, non-cash assets, or certain service performance.
PAS 1 Presentation of Financial Statements provides two (2) classifications for liability: current liability
and non-current liability.
Current Liabilities
As discussed in PAS 1, an entity shall classify a liability as current when (International Financial Reporting
Standards, 2001):
• It expects to settle the liability in its normal operating cycle;
• It holds the liability primarily for trading;
• The liability is due to be settled within 12 months after the reporting period; or
• It does not have an unconditional right to defer settlement of the liability for at least 12 months after
the reporting period. Terms of a liability that could, at the option of the counterparty, result in its
settlement by the issue of equity instruments do not affect its classification.
Some current liabilities, such as trade payables and some accruals for employees and other operating
costs, are part of the working capital used in the entity's normal operating cycle. An entity classifies such
operating items as current liabilities even if they are due to be settled more than 12 months after the
reporting period. The same normal operating cycle applies to the classification of an entity's assets and
liabilities. When the entity's normal operating cycle is not clearly identifiable, it is assumed to be 12 months
(International Financial Reporting Standards, 2001).
Other current liabilities are not settled as part of the normal operating cycle but are due for settlement within
12 months after the reporting period or held primarily for trading. Examples of these liabilities are as follows
(International Financial Reporting Standards, 2001):
• Financial liabilities that meet the definition of held for trading;
• Bank overdrafts;
• Current portion of non-current financial liabilities;
• Dividends payable;
• Income taxes; and
• Other non-trade payables.
In examining liabilities, an auditor places primary emphasis on verifying what is recorded and what could
not be recorded. The auditor seldom finds amounts recorded as liabilities that are not liabilities, but
unrecorded liabilities are not unusual. They are inherent in an accounting process with periodic reporting.
Thus, the year-end procedure for payable is primarily a test for understatement, called a "search for
unrecorded liabilities." Also, the audit procedures should provide evidence about the reasonableness of
liabilities that are already recorded and presented in the financial statements.
Nature and Sources of Accounts Payable

The term accounts payable describes short-term indebtedness arising from the purchase of goods and
services in the ordinary course of business. Typical transactions creating accounts payable include the
acquisition on the credit of merchandise, raw materials, property and equipment, and office supplies. Other
sources of accounts payable include the receipt of services, such as legal and accounting services, security,
advertising, repairs, and utilities.

used to achieve the objectives for current liabilities, specifically Accounts Payable and Notes Payable,
are as follows:
Existence or occurrence To determine that payables 1. Obtain from the client a listing of
exist as of the statement of accounts and notes payable as of
financial position date.

Page 15 of 22
year-end and reconcile to the

general ledger.
2. Vouch recorded liabilities to
vendors' statements.
3. Confirm recorded liabilities directly
with suppliers and creditors by
sending a confirmation letter.
Investigate differences in liabilities
as recorded versus the amount
confirmed by the supplier or
creditor.
4. Examine bank confirmation for
loans.
Completeness To determine that all 5. Perform purchase cut-off
transactions relating to payables examination.
have been properly recorded. 6. Test for unrecorded liabilities by
checking recorded payables
subsequent to the reporting period.
If the recorded payables are for
goods or services received as of
the reporting period, the same shall
be for adjustment and recording of
the entity.
7. Perform analytical procedures.
Rights and Obligations To determine that payables 8. In addition to audit procedure no. 3,
represent valid and legal claims review documentation in client's
of third parties from the client. files.
9. Examine subsequent payments to
creditors.
Valuation or Allocation To determine that payables are 10. Vouch accounts payable schedule.
recorded at the proper amount. 11. Test computation of accrued or
prepaid interest.
Presentation and To determine that payables are 12. Scan the list of payables to
Disclosure presented and disclosed determine that each major type of
according to PAS/PFRS. obligation is properly described and
classified. Determine that
contingent liabilities are properly
disclosed.
13. Obtain the client's representation
letter.
(Week 6) Audit of Non-current Liabilities
Introduction to Non-current Liabilities

As mentioned in PAS 1 Presentation of Financial Statements, all other liabilities not classified as current
are non-current.
A non-current liability, also known as a long-term liability, refers to a financial obligation in a company's
balance sheet that is expected to be paid after the period of one year. Non-current liabilities are due beyond
twelve months in the future, compared to short-term liabilities, which are due within one (1) year.
Long-term liabilities are usually substantial in amount and often extend beyond the current operating cycle
or one year, whichever is longer, or though payable within one year, will not be liquidated out of the existing
current assets. Long-term liabilities usually arise to finance long-term needs such as property, plant, and

Page 16 of 22
equipment acquisition, in contrast to current liabilities, which are normally incurred to finance short-term
working capital requirements.
Debentures, long-term loans, bonds payable, and notes payable (sometimes secured by mortgages or trust
deeds) are the principal types of non-current liabilities. Debentures are backed only by the general credit
of the issuing corporation and not by liens on specific assets. Since, in most respects, debentures have the
characteristic of other corporate bonds, we shall use the term bonds to include both debentures and bonds
payable.

used to achieve the objectives for non-current liabilities (Mortgage Payable, Bonds Payable, and Notes
Payable) are as follows:
Existence or occurrence To determine that long-term 1. Obtain analyses of long-term
debts exist at year-end debt accounts and related
interest, premium, and
discount accounts.
2. Review debt agreements
and confirm with payees the
principal amount, maturity
date, interest rate, etc.
3. Inspect bonds redeemed,
retired, or surrendered
during the period.
Completeness To determine that all 4. Trace authorization for
transactions relating to long- issuance of debt to credits to
term debts are properly the long-term debt account.
recorded 5. Vouch borrowing and
repayment transactions and
review transactions to
supporting documents
occurring near year-end.
Rights and Obligations To determine that long-term 6. Review minutes of the board
debts represent a valid of director's meetings.
obligation of the entity 7. Review payments and
renewals after the statement
of financial position date.
Valuation or Allocation To determine that the long-term 8. Recalculate interest
debts are recorded at the proper expense and amortization of
amount premium or discount, if any.
9. Ascertain the amount of
long-term debt maturing
within one (1) year.
Presentation and Disclosure To determine that long-term 10. Evaluate the presentation of
debts are presented and the long-term debt in the
disclosed in accordance with financial statements.
PAS/PFRS. Examine the classification of
obligation as either secured
or unsecured.
(Weeks 7-8) Audit of Shareholders' Equity
Introduction to Shareholders' Equity

Page 17 of 22
As discussed in Intermediate Accounting 2, shareholders' equity (SHE) is the residual interest of owners in
the net assets of a corporation measured by the excess of assets over liabilities. Generally, the elements
constituting SHE are:
a. Ordinary share capital
b. Preference share capital
c. Subscribed share capital
d. Share premium or additional paid-in capital
e. Retained earnings or accumulated profits
f. Revaluation surplus
g. Treasury shares
Components of shareholders' equity
Share capital issued Pxx

Subscribed share capital Pxx
Less: Subscription receivable xx
Share premium:
Share premium excess over par xx
Share premium – treasury shares xx
Share premium conversion option - convertible bonds payable xx
Donated capital xx
Share premium warrants outstanding xx
Share premium options outstanding xx xx
Total paid in capital xx
Retained earnings – unappropriated xx
Retained earnings – appropriated xx xx
Other comprehensive income (cumulative balance):
Revaluation surplus xx
Unrealized gain (loss) on FVOCI xx
Remeasurement gain (loss) under PAS 19 Employee Benefits xx
Translation gain (loss) xx
Effective portion of cash flow hedge xx
Change in fair value due to credit risk of designated FL@TPL xx xx
Total xx
Less: Treasury shares xx
Total shareholders' equity Pxx
• Contributed capital – It is also termed as paid-in capital. This represents the amounts contributed by
the owners to the corporation. It includes the share capital and share premium of the corporation.
• Legal capital – It is the portion of paid-in capital that cannot be returned to shareholders in any form
during the lifetime of the corporation.
1. With par value Share capital issued Pxx

Subscribed share capital xx
Pxx
2. No par value Share capital issued Pxx

Subscribed share capital xx
Paid-in capital in excess of stated value xx
Pxx
The following concepts must be noted:

Page 18 of 22
• The shareholders' equity section of the statement of financial position should be presented in
sufficient detail to provide a clear understanding of the corporation's capital structure and the
sources of capital currently in use.
• A corporation may issue different classes of share capital. Shares may be issued no-par or with
stated value; or with par value. Different classes include ordinary shares and preference shares.
When share capital is issued, its par value or stated value is credited to the share capital account.
The excess of the proceeds over the par or stated value is credited to share premium or additional
paid-in capital.
• Shares may be issued for cash or non-cash consideration. If the shares are issued for non-cash
consideration, the share capital is recorded at an amount equal to the following in order of priority:
1. Fair value of non-cash consideration received
2. Fair value of the share capital issued
3. Par value of the share capital issued.
• If there are share issue costs, they shall be debited to share premium arising from the share
issuance. If the share premium is insufficient to absorb such expenses, the excess shall be debited
to "share issuance costs" to be reported as a contra equity account as a deduction from the
following in the order of priority
1. Share premium from previous share issuance; and
2. Retained earnings.
• Treasury shares are shares originally issued by the corporation but reacquired for some purposes.
The cost method is used for accounting for the treasury shares in this example. Treasury shares
are recorded at cost regardless of whether it was acquired below or above par value. When
reissued, treasury shares are also credited at cost. Share premium account is adjusted for any
difference between the reissuance price and the cost of treasury shares. If the share premium is
insufficient to cover the difference, any remainder should be charged to retained earnings account.
• Retirement of share capital means redeeming the shares with a cancellation of the stock certificates
and reverting the shares to unissued basis.
• There are two (2) kinds of retained earnings: (1) Unappropriated retained earnings represent the
portion that is free and can be declared as dividends to shareholders. (2) Appropriated retained
earnings represent the portion that has been restricted and therefore not available for dividend
declaration.
• In any dividend distribution, only the outstanding shares are entitled to receive dividends.
• Share split does not affect the share capital of the company. It only increases or decreases the
number of outstanding shares outstanding and the par value, but the total share capital remains
the same.
• Detachable share warrants that are issued together with preference shares are recorded as equity
accounts for the amount of the proceeds allocated at the date of issuance. The allocation of the
issue price is based on the relative fair values of the detachable share warrants and preference
shares.
• Share warrants that are attached to bonds are assigned a portion of the proceeds using the residual
method. The market price of the bonds without the warrants is deducted from the total issue price,
and the remainder is assigned to the share warrants. When its holders exercise share warrants,
the amount of cash received plus the allocated value of the share warrants are credited to equity
accounts, share capital (at par value), and share premium for the excess over par.
• Share warrants outstanding is reported as part of the total share premium.
• Share options granted to key executives and officers of the company are recorded as compensation
expense over the period in which the services are received, measured at the fair value at the date
of grant. The amount of compensation expense recorded at each year of the vesting period is

Page 19 of 22
credited to an equity account called "Share Options Outstanding." The amount of cash received at
the time of exercise of the options, together with the appropriate balance of the Share Options
Outstanding, is credited to equity accounts, Share Capital, and Share Premium.

In examining shareholders' equity accounts, the auditor aims to determine (a) the propriety of the charges
and credits to the accounts, (b) the propriety of presentation of the accounts on the statement of financial
position, and (c) the client's compliance with relevant legal requirements. A summary of the management
assertions, audit objectives, and audit procedures for the shareholders' equity accounts are presented.

Existence or occurrence To determine the validity of 11. Obtain schedules of
recorded shareholders' equity shareholders' equity
balances and whether the accounts and reconcile them
transactions actually occurred. with the general ledger
balances.
12. Review authorizations and
terms of share issues.
13. Confirm shares outstanding
with registrar on share and
transfer agent.
14. Inspect share certificate
book.
15. Inspect certificates of shares
held in treasury.
Completeness To determine whether recorded 16. Perform analytical
shareholders' equity accounts procedures, in addition to
reflect all data that should be the above-mentioned
recorded. procedures.
Rights and Obligations To determine whether the entity 17. Review articles of
has the authority and execute incorporation and by-laws.
the shareholders' equity 18. Make inquiries of legal
transactions, e.g., whether counsel.
share capital was legally issued
and shareholders have a legal
claim on corporate assets at the
statement of financial position
date.
Valuation or Allocation To determine whether the 19. Vouch share capital entries,
shareholders' equity balances dividend entries, and entries
are shown in the proper to retained earnings.
statement amounts in
accordance with PAS/PFRS.
Presentation and Disclosure To determine that the 20. Review minutes of the board
shareholders' equity accounts of directors' and
are properly presented in the shareholders' meetings for
statement of financial position. share options and dividend
restrictions.
21. Evaluate financial statement
presentation and disclosure
for shareholders' equity
accounts.

Page 20 of 22
(Week 12) Correction of Errors
Accounting Errors
Errors are unintentional misstatements in the financial statements, including the omission of an amount or
a disclosure (Salosagcol, Tiu, & Hermosilla, 2018)
In general, accounting errors include the following types (Kieso, Weygandt, & Warfield, 2019):
1. A change from an accounting principle that is not generally accepted to an acceptable accounting
principle. The rationale is that the company incorrectly presented prior periods because of an
improper accounting principle. For example, a company may change from the cash (income tax)
basis of accounting to the accrual basis.
2. Mathematical mistakes, such as incorrectly totaling the inventory count sheets when computing the
inventory value.
3. Changes in estimates that occur because a company did not prepare the estimates in good faith.
For example, a company may have adopted a clearly unrealistic depreciation rate.
4. An oversight, such as the failure to accrue or defer certain expenses and revenues at the end of
the period.
5. A misuse of facts, such as the failure to use salvage value in computing the depreciation base for
the straight-line approach.
6. The incorrect classification of a cost as an expense instead of an asset, and vice versa.
Error Correction
Companies treat errors as prior period adjustments and report them in the current year as adjustments to
the beginning balance of Retained Earnings. If a company presents comparative statements, it restates the
prior affected statements to correct for the error.
The following are the types of errors:

• Statement of financial position errors. These are errors that affect only the presentation of an asset,
liability, or stockholders' equity account. Examples are classifying a short-term receivable as part of the
investment section, the classification of a note payable as an account payable, and the classification of
plant assets.
When the error is discovered, the company reclassifies the item to its proper position. If the company
prepares a comparative statement that includes the error year, it should correctly restate the balance
sheet for the error year.
• Income statement errors. Income statement errors involve the improper classification of revenues or
expenses. Examples include recording interest revenue as part of sales, purchases as bad debt
expense, and depreciation expense as interest expense. An income statement classification error has
no effect on the balance sheet and no effect on net income.
• Statement of financial position and income statement errors. These errors involve both statements
of financial position and income statement account. For example, assume that the bookkeeper did not
record accrual of wages payable at the end of the accounting period. The effect of this error is to
understate expenses, understate liabilities, and overstate net income for that period. This type of error
can be counterbalancing or non-counterbalancing.
o Counterbalancing errors. Those that will be offset or corrected over two (2) periods. These
are errors which when not detected within the subsequent financial year in which the errors
were committed, are automatically corrected as natural part of the accounting process. Most
counterbalancing errors are the result of year-end adjustment mistakes. These include
misstatement of inventories and the omission of adjustments for prepaid and accrued items at
the end of the period.

Page 21 of 22
o Non-counterbalancing errors. Those that are not offset in the next accounting period. These
are also known as permanent errors. Included in this class are errors such as the recognition
of a capital expenditure as expenses and the omission of charges for depreciation and
amortization. Thus, if an entity fails to depreciate an item of property, plant, and equipment or
amortize intangible assets, the cumulative effect of the failure to detect a depreciation or
amortization error will not be corrected until the end of the asset life or until the asset is sold. A
correcting journal entry is necessary for a non-counterbalancing error.
The following are common counterbalancing errors and their effects on the profits for two (2) periods.
Type of adjustment error Effect on profit for the Effect on profit for
current year next year
Ending inventory overstated Overstated Understated
Ending inventory understated Understated Overstated
Failure to accrue expense at year-end Overstated Understated
Overstated accrued expense at year-end Understated Overstated
Failure to accrue revenue at year-end Understated Overstated
Overstated accrued revenue at year-end Overstated Understated
Overstated year-end prepaid expense Overstated Understated
Understated year-end prepaid expense Understated Overstated
Understatement of year-end liability for Overstated Understated
revenue received in advance
Overstatement of year-end liability for revenue Understated Overstated
received in advance
Effect in the Net Income

If sales are overstated Overstated
If cost of sales is overstated Understated
If expenses are overstated Understated
Effect in Cost of Sales

If beginning inventories are overstated Overstated
If net purchases are overstated Overstated
If ending inventories are overstated Understated
Effect in working capital

If the current assets are overstated Overstated
If the current liabilities are overstated Understated
For a comprehensive audit case, refer to Pages 11-20 of 07 Handout 1 under 07 Evaluation of Audit
Evidence, Completion of Audit and Audit Reporting topic.

Page 22 of 22

Auditing and Assurance: Concepts and Applications 1

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BM2008/BM2015 – Auditing and Assurance: Concepts and Application 1 & 2

(Weeks 6-7) Audit of Cash ............................................................................................................................ 2

Auditing and Assurance: Concepts and Applications 2

(Weeks 1-2) Audit of Intangible Assets and Prepayments ......................................................................... 13

Third Year Comprehensive Examination (TYCE) Handout *Property of STI